Retirement planning for small business owners: What to consider

If you are a small business owner or planning to become one, retirement planning for both you and your employees should be a big consideration. 

Small business owners are not required to offer retirement services to employees. According to data collected by SCORE in 2019, companies with ten or less employees are the least likely to offer retirement plans to their employees compared to larger businesses. Additionally, only about half of businesses with 10-50 employees offer retirement plans, with the biggest reason being cost to establish or administer a plan. Even 22% said they hadn’t even considered providing this benefit. 

However, just because you are not required to offer retirement plans as a small business owner doesn’t mean you shouldn’t. The same study by SCORE revealed that offering employees retirement plans helps with recruitment and retention of the best-qualified employee candidates. And, it’s not nearly as expensive as most people think, meaning that (in most cases), the benefits far outweigh the costs. 

…but if you want to save for yourself you have to help your employees save, too

Timothy Catanzano, AIF®, Director of Retirement Plans at Pegasus Financial Planning, specializes in business retirement planning, and he knows that cost is typically the number one concern for most business owners when it comes to choosing the right retirement plan. “Depending on the size of your organization, generally speaking, it’s going to come down to fees right away — cost — and what you can afford to do,” he says.

What many owners don’t realize is that if they want to put money away for themselves, they’re going to have to give a good chunk to their employees too. Catanzano iterates that this is where the expense comes into play.

Putting a plan in place isn’t as simple as deciding that you want to save for yourself and determining how much it will cost. “It’s not [just about] the cost of the overall program itself, like the recordkeeping expenses and the administrative costs of running a 401(k). There’s a lot that goes way beyond that,” he explains.

These costs will depend on the plan you chose, the utilization rates, and size of your business, among other things. Catanzano continues, “It may cost you, maybe 5% of your overall payroll, for example, that you’re going to have to give to your employees. But that’s for you to be able to put away as much as you possibly would like to.”  

When choosing your plan, be sure that you’re getting the full scope of both the benefits and costs of each. “If the planner or advisor comes in and sells the plan and doesn’t design it effectively, it ends up underutilized and falling to the wayside, becoming a waste of money for the owner,” he cautions. Working with a good financial professional is important to discuss what your budget is, what the utilization rates of the plan are going to be, and what your ultimate goals are.

Besides the incentives that offering retirement benefits have for your current and prospective employees, there are incentives for you as well. Yes, helping yourself save for retirement involves helping your employees save, but there are also tax benefits involved in offering retirement plans to your employees.

First, employer contributions to employee accounts are tax-deductible, which is an incentive offered by the government to encourage small businesses to provide retirement plans to their employees. There are also tax credits available that you may be eligible for. The Retirement Plans Startup Costs Tax Credit allows eligible employers to receive a credit of up to $5,000 for three years to cover the costs of starting a plan.

The money contributed to the retirement plan on behalf of the business is essentially “money you’re taking out of the government’s hands from taxing you,” Catanzano clarifies.

SEPs, SIMPLEs, 401(k)s…choosing a retirement plan that fits your business and what you’re trying to achieve depends on cost as well, among other things, and how much you’re looking to put away for your own retirement. Determining how much you would like to put away often dictates what’s the most suitable. Catanzano says, “Evaluating needs, how much you can afford, how much you want to save, and what’s the intent — it really comes down to specific business needs.” 

With a simplified employee pension (SEP), you make contributions into the IRAs of individual employees. These often offer high flexibility and low administrative costs. SEPs typically work well for closely-held businesses with few to no employees. Employees have control over their accounts and investments, and, therefore, the plan is very easy to maintain.

In 2021, SEPs allow a maximum contribution of $58,000 or 25% of compensation, whichever is less.

Savings Incentive Match Plan for Employees (SIMPLE) IRAs offer lower maximum contributions than SEPs and 401(k)s. If you have little means to run a plan, but you want to be able to put away some for yourself as the business owner, a SIMPLE might make more sense for you, especially if you’re expecting minimal participation, Catanzano explains.  

“Usually with a SIMPLE, you don’t get a lot of participation from your employees,” he says. “So, the outlay from you as the employer is very minimal because you’re only matching 3%, or whatever it may be, and if you only have a handful of people contributing, that’s not a lot that you have to spend to run the plan.” With a SIMPLE, you’re required to either match employee contributions up to the first 3% of compensation, or contribute 2% of each eligible employee’s compensation.

While you can’t put as much into a SIMPLE compared to the other two plans mentioned, they are simple and inexpensive to set up and maintain. Because of this, however, investment selections are limited, unlike with 401(k)s, and employees must manage them on their own or hire an advisor.

On the other hand, if you’re looking to put more away for yourself and you run a private for-profit organization, a 401(k) probably might make more sense. “There’s all sorts of features you have to look at, like profit sharing with a 401(k) plan and doing new comparability so that the owner gets more of the profit sharing contributions in their pocket,” Catanzano acknowledges.

401(k)s are typically the best plans for maximizing employer contributions. Employees primarily fund their 401(k)s, and you as the employer have the option to make additional contributions. They’re most efficient for medium-to-large businesses because of their higher administrative costs. 

There are many more retirement plan options in addition to the ones discussed in this article, although these are three of the most common. Working with a financial professional will allow you to talk through the needs of your business and your retirement goals to choose the best plan for you and your employees.